Restrictive Covenants: Employment Contracts -v- Commercial Agreements

Restrictive covenants/post-termination restrictions play an essential role in protecting business interests such as confidential information and commercial connections. These protections are most commonly found in employment contracts and certain types of commercial agreements.

When assessing the enforceability of post-termination restrictions in an employment contract, the starting point is that such restrictions will be considered void as a restraint of trade unless it can be shown that they go no further than reasonably necessary to protect a legitimate business interest.

By way of contrast restrictive covenants contained in commercial agreements such as share purchase agreements (SPAs) and shareholder agreements do not ordinarily attract the restraint of trade principle and as such are more readily enforceable, compared with an employment contract and often apply a wider level of restriction.

However, the recent case of Literacy Capital Plc v Webb [2024] EWHC 2026 (KB), has confirmed this will not always be the case.

In the case, the Claimant (Literacy Capital) acquired the Respondent’s 25% shareholding in Mountain Healthcare Limited. As part of the share sale a number of restrictions were included in the sale documentation which effectively prevented the Respondent from competing with any business of Literacy’s subsidiaries in the UK and Channel Islands for:

1. 12 months of ceasing to be a director or employee of all such subsidiaries; and
2. the period commencing when she became a loan note holder and ending 12 months after she ceased to be such (potentially a period of 10 years).

Based on the general principles set out above, the restrictions in the SPA would not ordinarily attract the restraint of trade principle. However, in this instance the court concluded that as the restrictive covenants had arisen directly from Respondent’s status as an employee, founder, grower and vendor of Mountain Healthcare they would in fact attract the restraint of trade principle that would be applied if it were an employment contract.

Applying these principles, the court concluded that there was no arguable issue about the covenants’ lack of validity as they were clearly void and unenforceable. The core reasons for them coming to this conclusion was that Literacy Capital could not justify the necessity of a 10-year restrictive covenant, that they could not justify a nationwide covenant and that the covenant did not only seek to protect Mountain’s business but also that of any other subsidiaries, irrespective of whether or not the Respondent had any connection or involvement with them.

What does this mean for you?

In Financial Services, shares or stock options are commonly used to reward employees either in the course of their employment or perhaps at the time of a sale and can often result in employees being asked to sign commercial agreements such as shareholder agreements or SPAs which contain restrictions.

Where there is a close connection between the employment relationship and the commercial agreements, businesses need to give careful consideration to any restrictions that may be applied. If they are too broadly drafted, in light of this recent case, there is a significant risk that the restrictions will be treated in the same way as they would have been had they been contained in a contract of employment. That could see such restrictions being held to be void as a restraint of trade and not provide the business with the necessary protections.

As such, care needs to be taken when drafting restrictions in agreement outside of the employment contract. If they can be linked to the employment relationship, a more limited approach will need to be taken to the drafting of any restrictions, compared to a genuinely “arms length” commercial relationship.

If you would like to further discuss any points made in this article, please contact us to speak to a member of our Employment Team.